On Our Radar

On Our Radar

5 Insights from Main Street Capital Corp. 4Q Update

Every year, Main Street Capital Corp. releases its fourth-quarter update. It's an earnings report before the actual report -- a way to bridge the gap in time between its early November and late February earnings releases.

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I just worked my way through the update. Here are some of the details investors should focus on now.

1. The dividend is covered and should grow in 2015The company reported that it will cover its dividends with distributable net investment income, or DNII, in the fourth quarter of 2014 (which will be reported in late February) as well as the first quarter of 2015.

Earnings should be in the high-end of its previous guidance for $0.58-$0.60 in DNII in the fourth quarter.

Main Street currently pays out about $2.59 in annual dividends when you include its two special dividends each year. The company now expects that it can increase its annual rate to more than $2.60 per share for 2015 by increasing its current monthly dividend.

2. The fourth quarter had its ups and downsAs an active buyer and seller of private investments, portfolio turnover is certain. In the fourth quarter, it realized gains of about $12 million on its lower middle market portfolio. That is, it sold investments at prices $12 million above their historical cost.

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The middle market portfolio of loans to larger businesses showed weaker performance, largely because of falling loan prices across the board. Yields on new issues were roughly 0.7% higher at the end of the fourth calendar quarter compared to the end of the third quarter, according to LeveragedLoan. Reading between the lines, it appears as though these losses have not been realized.

Main Street expects that its net asset value (book value) should be relatively unchanged as realized and unrealized gains in its lower middle market investments offset the middle market portfolio's unrealized losses.

3. Main Street has more oil exposure than its peersOil is stealing the show in the high-yield world, and Main Street has more exposure to oil companies than the average BDC -- 9.8% at fair value vs. the average of 7% as previously reported by KBW. This is will be something to watch in the coming quarters, as we see the effects of lower oil and gas prices on small producers.

Investors need to take a hard look at its marks when the company's annual report comes out. Main Street Capital, being a Houston-based company, has more exposure to Texas than most BDCs. And the Texas economy obviously has more exposure to the oil industry than other geographic areas. Thus, it also has some indirect exposure to oil prices, which isn't reflected in the percentages above.

Without getting too off track, it is worth mentioning lower oil prices hurt producers, but help oil consumers -- businesses and individuals. Given Main Street's higher-than-average equity exposure, it should capture some benefit from lower oil prices in other portfolio companies. We'll have to see how this shakes out across the BDC industry.

4. Another portfolio company went on non-accrualMain Street revealed a few non-accrual companies in the first three quarters of 2014. One more was added to the list in the fourth quarter.

Non-accrual assets now make up 1.7% and 4.7% of investments at fair value and cost, respectively. It does note, however, that one should move off non-accrual in the first quarter, which would effectively keep its non-accrual rate unchanged from the third quarter.

5. Its asset manager is adding assets quicklyMain Street Capital advises a private BDC, for which it earns fees equal to 1% of assets and 10% of returns. That BDC had "approximately $500 million" in assets at the end of the fourth quarter, compared to $386 million in the third quarter.

This is significant. Ongoing management fees would total $5 million per year, and incentive fees could add another $4 million at the current level of assets, based on its share of performance at an 8% return on equity.

A Foolish perspectiveThere are some positives and negatives, which investors should expect, given the rout in oil prices and declining middle market loan prices. It's my view that most BDCs will report write downs on oil-related investments when earnings reports come out in February.

Main Street Capital has more exposure than most. However, given the company's focus on minimizing its operating costs, its record of producing realized gains in excess of losses, and its non-energy equity investments, I'm not particularly concerned about oil exposure's impact on the company.

Just to give some historical perspective, Main Street Capital had plenty of losers in the months following the financial crisis. However, it tends to lets its winners ride, and its winners have more than made up for its losers over history. Unless I see evidence of a big shift in the performance of its portfolio companies, it still deserves a place among the top BDCs.